Tuesday, June 26, 2012

More Reforms Needed to Relieve Maryland's Pension Liability Problems

The Pew Center On States' June 2012 Issue Brief, "
Widening the Gap Update" spotlights the problem of states' unfunded liabilities for public sector pensions and retiree health care. According to the Issue Brief:
In fiscal year 2010, the gap between states' assets and their obligations for public sector retirement benefits was $1.38 trillion, up nearly 9 percent from fiscal year 2009. Of that figure, $757 billion was for pension promises, and $627 billion was for retiree health care. 
Count Maryland among the many states whose irresponsibility in state budgeting practices puts them into pension liability predicaments. The Pew Center's
Fact Sheet on Maryland points out that Maryland has failed to pay in full its annual pension contributions since 2005. As of fiscal year 2010, Maryland's pension deficit was $20 billion, and the state had only funded 1 percent of its $16 billion obligation for retiree health care.

Also count Maryland among those states that have recently undertaken a number of reforms to shore up their pension and health care funding shortfalls. As the Fact Sheet explains:
Maryland lawmakers approved pension cuts in 2011, including increasing contributions from current and future employees and reducing annual cost-of-living increases for retirees. Lawmakers also reduced retiree health care benefits by requiring higher co-payments for prescription drugs.
But like many other states, Maryland has more reforming work to do. As the Issue Brief puts it, "continued fiscal discipline and additional reforms will be needed to put states back on a firm footing."

Next steps for Maryland to shore up its unfunded obligations should include:
  • Adjusting its annual return on investment assumptions. Maryland's pension system assumes a rosy 7.75 percent annual return on investment. True, investments enjoyed high returns over the last two fiscal years. But with stocks tumbling in 2008 and 2009, that same investment return assumption is responsible for significant funding shortfalls. A May 27 New York Times article, for instance, cites a National Association of State Retirement Administrators' finding of an average 5.7 percent return for state pensions over the last ten years.
  • Increasing and meeting its annual pension contribution amount. As explained in a June 20 MarylandReporter.com article, Maryland continues to rely on the "corridor methodology" as a means of avoiding full pension funding for each year. Under this method, the state can make annual pension contributions equal to the prior year's contributions plus 20% of the difference between the prior year's contributions and what it otherwise would have had to contribute in the current year. By eliminating the corridor method and increasing its annual payments, Maryland should meet its obligations in full, every year.
  • Transitioning to a defined contribution or hybrid plan. As we've explained in prior blog posts, Maryland should transition future employees from a defined benefit pension (where benefits are determined by a set formula) to a defined contribution pension (where benefits are determined by investment returns). The Issue Brief points out that thirteen states have hybrid plans, with neighboring Virginia adopting a hybrid plan in 2012. Such plans combine features of defined benefit and defined contribution plans. A transition to a defined contribution or hybrid plan would more closely tie benefits to market performance, reducing the state's obligation to provide additional pension funding when markets experience economic downturn.

Further delay by Maryland in reforming its pension system will make it that much harder to achieve fiscal responsibility.